What is Margin Trading?
Practice of buying stock with money borrowed from the broker. In this arrangement, the investor makes a cash down payment (called the margin) with the broker and can purchase stocks worth about twice the cash amount. The broker charges interest on this loan (in addition to the commission on each buy/sell trade) and the investor has to keep the entire stockholding with the broker as collateral. Also, the investor has to put upadditionalcash in case the value of the stockholding falls below a certain amount. Margin trading is a double-edged sword – it cuts both ways. If the stock price rises, the investor makes twice as much profit as with his own cash only.
A margin account lets you leverage securities you already own as collateral for a loan to buy additional securities.
Margin is the money borrowed from a brokerage firm to purchase an investment. It is the difference between the total value of securities held in an investor’s account and the loan amount from the broker. Buying on Margin is the act of borrowing money to buy securities. The practice includes buying an asset where the buyer pays only a percentage of the asset’s value and borrows the rest from the bank or broker. The broker acts as a lender and the securities in the investor’s account act as collateral.
In a general business context, the margin is the difference between a product or service’s selling price and the cost of production, or the ratio of profit to revenue. A margin can also refer to the portion of the interest rate on an adjustable-rate mortgage (ARM) added to the adjustment-index rate.
A margin refers to the amount of equity an investor has in their brokerage account. “To margin” or “to buy on margin” means to use money borrowed from a broker to purchase securities. You must have a margin account to do so, rather than a standard brokerage account. A margin account is a brokerage account in which the broker lends the investor money to buy more securities than what they could otherwise buy with the balance in their account.
Using margin to purchase securities is effectively like using the current cash or securities already in your account as collateral for a loan. The collateralized loan comes with a periodic interest rate that must be paid. The investor is using borrowed money, or leverage, and therefore both the losses and gains will be magnified as a result. Margin investing can be advantageous in cases where the investor anticipates earning a higher rate of return on the investment than what he is paying in interest on the loan.
For example, if you have an initial margin requirement of 60% for your margin account, and you want to purchase $10,000 worth of securities, then your margin would be $6,000, and you could borrow the rest from the broker.
- Margin refers to money borrowed from a brokerage to trade securities.
- Margin trading therefore refers to the practice of using borrowed funds from a broker to trade a financial asset, which forms the collateral for the loan from the broker.
- A margin account is a standard brokerage account in which an investor is allowed to use the current cash or securities in their account as collateral for a loan.
- The collateralized loan comes with a periodic interest rate that the investor must repay to the broker.
- Leverage conferred by margin will tend to amplify both gains and losses. In the event of a loss, a margin call may require your broker to liquidate securities without prior consent.
Buying on Margin
Buying on margin is borrowing money from a broker in order to purchase stock. You can think of it as a loan from your brokerage. Margin trading allows you to buy more stock than you’d be able to normally. To trade on margin, you need a margin account. This is different from a regular cash account, in which you trade using the money in the account.
By law, your broker is required to obtain your consent to open a margin account. The margin account may be part of your standard account opening agreement or may be a completely separate agreement. An initial investment of at least $2,000 is required for a margin account, though some brokerages require more. This deposit is known as the minimum margin. Once the account is opened and operational, you can borrow up to 50% of the purchase price of a stock. This portion of the purchase price that you deposit is known as the initial margin. It’s essential to know that you don’t have to margin all the way up to 50%. You can borrow less, say 10% or 25%. Be aware that some brokerages require you to deposit more than 50% of the purchase price.
You can keep your loan as long as you want, provided you fulfill your obligations such as paying interest on time on the borrowed funds. When you sell the stock in a margin account, the proceeds go to your broker against the repayment of the loan until it is fully paid. There is also a restriction called the maintenance margin, which is the minimum account balance you must maintain before your broker will force you to deposit more funds or sell stock to pay down your loan. When this happens, it’s known as a margin call. A margin call is effectively a demand from your brokerage for you to add money to your account or close out positions to bring your account back to the required level. If you do not meet the margin call, your brokerage firm can close out any open positions in order to bring the account back up to the minimum value. Your brokerage firm can do this without your approval and can choose which position(s) to liquidate. In addition, your brokerage firm can charge you a commission for the transaction(s).
You are responsible for any losses sustained during this process, and your brokerage firm may liquidate enough shares or contracts to exceed the initial margin requirement.
Borrowing money isn’t without its costs. Indeed, marginable securities in the account are collateral. You’ll also have to pay the interest on your loan. The interest charges are applied to your account unless you decide to make payments. Over time, your debt level increases as interest charges accrue against you. As debt increases, the interest charges increase, and so on. Therefore, buying on margin is mainly used for short-term investments. The longer you hold an investment, the greater the return that is needed to break even. If you hold an investment on margin for a long period of time, the odds that you will make a profit are stacked against you.
Not all stocks qualify to be bought on margin. The Federal Reserve Board regulates which stocks are marginable. As a rule of thumb, brokers will not allow customers to purchase penny stocks, over-the-counter Bulletin Board (OTCBB) securities or Initial Public Offerings (IPOs) on margin because of the day-to-day risks involved with these types of stocks. Individual brokerages can also decide not to margin certain stocks, so check with them to see what restrictions exist on your margin account.
A Buying Power Example
Let’s say that you deposit $10,000 in your margin account. Because you put up 50% of the purchase price, this means you have $20,000 worth of buying power. Then, if you buy $5,000 worth of stock, you still have $15,000 in buying power remaining. You have enough cash to cover this transaction and haven’t tapped into your margin. You start borrowing the money only when you buy securities worth more than $10,000.
This brings us to an important point: the buying power of a margin account changes daily depending on the price movement of the marginable securities in the account. Later in the tutorial, we’ll go over what happens when securities rise or fall.
Other Uses of Margin
In business accounting, a margin refers to the difference between revenue and expenses, where businesses typically track their gross profit margins, operating margins, and net profit margins.
The gross profit margin measures the relationship between a company’s revenues and the cost of goods sold (COGS). Operating profit margin takes into account COGS and operating expenses and compares them with revenue, and net profit margin takes all these expenses, taxes and interest into account.
Margin in Mortgage Lending
Adjustable-rate mortgages offer a fixed interest rate for an introductory period of time, and then the rate adjusts. To determine the new rate, the bank adds a margin to an established index. In most cases, the margin stays the same throughout the life of the loan, but the index rate changes.
To understand this more clearly, imagine a mortgage with an adjustable rate has a margin of 4% and is indexed to the Treasury Index. If the Treasury Index is 6%, the interest rate on the mortgage is the 6% index rate plus the 4% margin, or 10%.
Here’s an example Of trading on margin:
Suppose you use $5,000 in cash and borrow $5,000 on margin to buy a total of $10,000 in stock. If the stock rises in value to $11,000 and you sell it, you would pay back the $5,000 borrowed on margin and realize a profit of $1,000. That’s a 20% return on your $5,000 investment.
If you didn’t use a margin loan, you would have paid $10,000 in cash for the stock. Not only would you have tied up an additional $5,000, but you would have realized only a 10% return on your investment. The 10% difference in the return is the result of leveraging your assets.However, leverage works as dramatically when stock prices fall as when they rise. For example, let’s say you use $5,000 in cash and borrow $5,000 on margin to purchase a total of $10,000 in stock. Suppose the market value of the stock you’ve purchased for $10,000 drops to $9,000. Your equity would fall to $4,000, which is the market value minus the loan balance of $5,000. In this instance, you could suffer a loss of 20% due to a 10% decrease in market value. This example does not account for any fees, commissions, interest, or taxes you may be required to pay.
What securities are eligible collateral for margin borrowing?
You can use these securities as collateral for margin borrowing:
Equities and ETFs trading over $3 a share (special requirements exist for certain securities and accounts)
Most mutual funds that you’ve owned for at least 30 days
Treasury, corporate, municipal, and government agency bondsYou cannot use these securities as collateral for margin borrowing:
- Money Market funds
- Offshore mutual funds
What is a margin call?
If the margin equity in your account falls below security requirements then your account is issued a margin call. If your account is issued a margin call, you must deposit more money or marginable securities in your account or sell a position. See Day trading under Trading Restrictions for more information.You’ll find more information—including types of margin calls, how calls are triggered, and how to meet a margin call—in the FAQs under “How does margin work?”
What are the risks associated with margin?
Margin investing carries greater risks and may not be appropriate for everyone. Before you use margin, carefully review your investment objectives, financial resources, and risk tolerance to determine whether margin borrowing is right for you. Here are some of the risks that you should think about before you get started:
Leverage risk: Leverage works as dramatically when stock prices fall as when they rise. For example, let’s say you use $5,000 in cash and borrow $5,000 on margin to purchase a total of $10,000 in stock. Suppose the market value of the stock you’ve purchased for $10,000 drops to $9,000. Your equity would fall to $4,000, which is the market value minus the loan balance of $5,000. In this instance, you could suffer a loss of 20% due to a 10% decrease in market value.This example does not account for any fees, commissions, interest, or taxes you may be required to pay.
Margin call risk: If the securities you hold fall below the minimum maintenance requirement, your account will incur a margin call. Margin calls are due immediately. It’s smart to leave a cushion in your account to help reduce the likelihood of a margin call. Sometimes you may face higher maintenance minimums, especially when the securities you’re using as collateral carry additional risks, such as risks derived from concentrating your investments in one area or sector.
Short selling is also a margin account transaction that entails the same risks as a margin call along with some added risks. When you short sell a security, you’re combining several different investment strategies to potentially profit if a particular stock drops in value. However, if that shorted security rises in value, you can incur a loss that might be unlimited. In addition, you might be charged a short interest fee on the securities you borrowed to sell short; those fees can change—sometimes significantly—without warning.All short sale orders are subject to the availability of the stock being borrowed, which must be confirmed by Fidelity prior to the order being entered. The availability of this borrowed stock to initiate and maintain a short sale position can change at any time, which could increase the likelihood of a buy-in of your short position. If you’d like more information, see About short selling.
What are my responsibilities for my margin account?
Before using margin, you must be fully aware of the trading risks and requirements. You must ensure your account holds the minimum equity to cover a trade before you place it. If the equity in your account is not sufficient or Fidelity believes the risk is too great, we can sell your assets at any time. If we have to make repeated account liquidations, we may restrict or terminate your account per the Customer Agreement.
- What are the types of margin calls and how do I meet them?
- Margin call information is provided to help you understand when your account is in a call and see what amounts are due and when. The method and time for meeting a margin call varies, depending on the type of call.
- Call Type: House Sell margin-eligible securities held in the account, or
- Deposit cash or margin-eligible securities. Time allowed: 4 business days. The broker reserves the right to meet margin calls in your account at any time without prior notice.
- ExchangeAccount margin equity falls below exchange requirements.
- Sell margin-eligible securities held in the account, or
- Deposit cash or margin-eligible securities. Time allowed: 2 business days. The broker reserves the right to meet margin calls in your account at any time without prior notice. FederalEquity is insufficient to satisfy the 50% initial requirement on an opening transaction.
- Sell margin-eligible securities held in the account, or
- Deposit cash or margin-eligible securitiesNote: Repeatedly liquidating securities to cover a federal call while below exchange requirements may result in restrictions on margin trading in the account.Time allowed: 4 business days. The broker reserves the right to meet margin calls in your account at any time without prior notice.
- Day trade A day trade exceeds your account’s day trade buying power.
- Deposit of cash or marginable securities only. A sale of an existing position may satisfy a day trade call but is considered a day trade liquidation. 3-day trade liquidations within a 12-month period will cause the account to be restricted. Note: There is a 2-day holding period on funds deposited to meet a day trade call. Time allowed: 5 business days. The broker reserves the right to meet margin calls in your account at any time without prior notice. Day trade minimum equityMargin equity falls below the $25,000 pattern day trader equity requirement.
- Deposit of cash or marginable securitiesNote: There is a 2-day holding period on funds deposited to meet a day trade minimum equity call.Time allowed: 5 business daysFidelity reserves the right to meet margin calls in your account at any time without prior notice.
What creates margin calls and when are they due?
Margin calls occur because your account has dropped in value either because the value of your holding has dropped, or because you’ve withdrawn cash or securities from your account so you no longer have enough account equity to meet the margin requirement.
What are my responsibilities for my margin account?
Before using margin, you must be fully aware of the trading risks and requirements. You must ensure your account holds the minimum equity to cover a trade before you place it. If the equity in your account is not sufficient or the broker believes the risk is too great, the broker can sell your assets at any time. If the broker has to make repeated account liquidations, the broker may restrict or terminate your account per the Customer Agreement.
When do I use my intraday buying power balance vs. margin buying power?
If you’re trading using your intraday buying power balance, the expectation is that positions are liquidated prior to the close of the trading session in which you opened the position. Using the intraday buying power balance to open a position and hold it overnight increases the likelihood that a margin call is issued and due immediately. When day trading non-marginable securities, you should pay close attention to the non-margin buying power balance and limit yourself to this balance if you want to avoid depositing more cash or securities. Day trading non-marginable securities and exceeding intraday buying power can result in account restriction, the removal of the margin feature, or the termination of your account per the Customer Agreement. The broker monitors accounts and we conduct reviews throughout the day. If your account requires attention, you may receive an alert indicating that you must take immediate action. You should be aware of the risks involved when you use your intraday buying power balance and be prepared to deposit cash or marginable securities immediately. If the equity is too low, account liquidation can occur immediately without the broker notifying youIf you’re unsure if you’ll close a position or several positions in the same trading session, use the Margin Calculator and use your margin buying power balance
What is the difference between trading in cash account vs. trading on margin?
When you place trades in a cash account, you can only buy and sell securities with cash. You can’t borrow against your securities to make purchases. When using your cash account, you must pay in full for your purchases and deliver securities for your sales by the trade settlement dates. However, if you place trades in a margin account, you can leverage the equity in securities you already own to purchase additional securities.
If you have a margin account, remember to place trades in the margin account type (which is the default). By selecting this account type, your available cash is used to pay for your trades before creating a margin loan for you. Additionally, by using the margin account type, the settlement times only impact the ability to withdraw funds. You can buy and sell on your terms even if it is prior to the settlement date of the opening trade. See Trading Restrictions, Day trading for additional information.
If you place a trade in your margin account, and you select the cash account type, you no longer get the benefits of holding securities in margin and you must follow the trade settlement rules for a cash account.
If your goal is to hold the securities in margin but avoid getting charged the margin interest, use your balance under “Available to trade without margin impact.”